Internap Network Services Corp (INAP) SEC Quarterly Report (10-Q) for Q3 2016

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2016

OR

For the transition period from _______ to ______

Commission File Number: 001-31989

INTERNAP CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  x  No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  ¨  No  x

As of September 30, 2016, 58,245,920 shares of the registrant's outstanding common stock, $0.001 par value per share, were outstanding.

INTERNAP CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2016

TABLE OF CONTENTS

ITEM 1. FINANCIAL STATEMENTS

The accompanying notes are an integral part of these condensed consolidated financial statements.

The accompanying notes are an integral part of these condensed consolidated financial statements.

INTERNAP CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

The accompanying notes are an integral part of these condensed consolidated financial statements.

INTERNAP CORPORATION AND SUBSIDIARIES

UNAUDITED CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Internap Corporation ("we," "us" or "our") provides high-performance Internet infrastructure services at 51 data centers across North America, Europe and the Asia-Pacific region and through 83 Internet Protocol ("IP") service points.

We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information. These financial statements include all of our accounts and those of our wholly-owned subsidiaries. We have eliminated all intercompany transactions and balances in the accompanying financial statements.

We have condensed or omitted certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP. In the opinion of management, the accompanying financial statements reflect all adjustments, which consist of normal recurring adjustments unless otherwise disclosed, necessary for a fair statement of our financial position as of September 30, 2016 and our operating results and cash flows for the interim periods presented. The balance sheet at December 31, 2015 was derived from our audited financial statements, but does not include all disclosures required by GAAP. You should read the accompanying financial statements and the related notes in conjunction with our financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the Securities and Exchange Commission.

The preparation of financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Actual results may differ materially from these estimates. The results of operations for the three and nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for any future periods.

During the three months ended March 31, 2016, we changed our organizational structure in an effort to create more effective and efficient operations and to improve customer and product focus. In that regard, we revised the information that our chief executive officer, who is also our chief operating decision maker, regularly reviews for purposes of allocating resources and assessing performance. As a result, beginning January 1, 2016, we report our financial performance based on our new segments, described in note 10 "Operating Segments." We have reclassified prior period amounts to conform to the current presentation.

In addition, in conjunction with the change in our organizational structure, we reclassified certain costs included in the expense categories on our consolidated statement of operations, which resulted in the following: a reclassification of "Sales and marketing" and "General and administrative" to "Sales, general and administrative" and "Direct costs of amortization of acquired and developed technologies" to "Depreciation and amortization" included on our accompanying consolidated statements of operations. We have reclassified prior period amounts to conform to the current presentation.

The prior year reclassifications, which did not affect total revenues, total direct costs of sales and services, operating loss or net loss, are summarized as follows (in thousands):

SGA expense consists primarily of costs related to sales and marketing, compensation and other expense for executive, finance, product development, human resources and administrative personnel, professional fees and other general corporate costs.

We account for certain assets and liabilities at fair value. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. We categorize each of our fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:

Assets and liabilities measured at fair value on a recurring basis are summarized as follows (in thousands):

The following table provides a summary of changes in our Level 3 asset retirement obligations for the nine months ended September 30, 2016 (in thousands):

The fair values of our other Level 3 debt liabilities, estimated using a discounted cash flow analysis based on incremental borrowing rates for similar types of borrowing arrangements, are as follows (in thousands):

During the three months ended September 30, 2016, we determined that we would not use certain internally-developed software related to our quoting and billing system, which affects both of our reportable segments, and recorded an impairment of $1.6 million. We include the impairment in "Exit activities, restructuring and impairments" in the consolidated statements of operations and comprehensive loss for the three and nine months ended September 30, 2016.

During the three months ended March 31, 2016, we changed our operating segments, as discussed in note 10 "Operating Segments," and, subsequently, our reporting units. We now have five reporting units: IP services, IP products, data center services ("DCS"), cloud and hosting services and hosting products. We allocated goodwill to our new reporting units using a relative fair value approach. In addition, we completed an assessment of any potential goodwill impairment for all reporting units immediately prior to and after the reallocation and determined that no impairment existed.

We performed our annual impairment review as of August 1, 2016. To determine the estimated fair value of our reporting units, we utilized the discounted cash flow and market methods. We have consistently utilized both methods in our goodwill impairment assessments and weighted both as appropriate based on relevant factors for each reporting unit. The discounted cash flow method is specific to our anticipated future results of the reporting unit, while the market method is based on our market sector including our competitors.

We determined the assumptions supporting the discounted cash flow method, including the discount rate, using our estimates as of the date of the impairment review. To determine the reasonableness of these assumptions, we considered our past performance and empirical trending of results, looked to market and industry expectations and further performed various sensitivity analyses on certain of the assumptions used in the discounted cash flow method, such as forecasted revenues and discount rate. We used reasonable judgment in developing our estimates and assumptions. The market method estimates fair value based on market multiples of revenue and earnings derived from comparable companies with similar operating and investment characteristics as the reporting unit.

The assumptions, inputs and judgments used in performing the valuation analysis are inherently subjective and reflect estimates based on known facts and circumstances at the time we perform the valuation. These estimates and assumptions primarily include, but are not limited to, discount rates; terminal growth rates; projected revenues and costs; earnings before interest, taxes, depreciation and amortization for expected cash flows; market comparables and capital expenditure forecasts. The use of different assumptions, inputs and judgments, or changes in circumstances, could materially affect the results of the valuation. Due to inherent uncertainty involved in making these estimates, actual results could differ from our estimates and could result in additional non-cash impairment charges in the future.

During our annual impairment assessment, we determined based on the step 1 test that the fair value of each of our IP services, IP products and DCS reporting units, all included within our Data Center and Network Services segment, was below its carrying value. We then started the step 2 test on each of these reporting units. For the three months ended September 30, 2016, based on the initial result of our step 2 test, we recorded an impairment estimate of $78.2 million to adjust goodwill in our Data Center and Network Services segment, leaving a remainder of $1.9 million of goodwill in this segment. Due to the complexity and the effort required to estimate the fair value of the IP services, IP products and DCS reporting units in step 1 of the impairment test and to estimate the fair value of all assets and liabilities of each of the reporting units in step 2 of the test, we derived the fair value estimates based on preliminary assumptions and analysis that are subject to change. We will record any adjustment to the estimated impairment charge in the fourth quarter of 2016.

The goodwill impairment is primarily due to declines in our data center services, IP services and IP products revenues and operating results as compared to our projections. The declines in revenues and operating results compared to projections are attributable to lower than expected demand creation and customer retention. 

Prior to conducting step 1 of the goodwill impairment test for the IP services, IP products and DCS reporting units, we evaluated the recoverability of the long-lived assets, including purchased intangible assets. When indicators of impairment are present, we test long-lived assets (other than goodwill) for recoverability by comparing the carrying value of an asset group to its undiscounted cash flows. We considered the lower than expected revenue and profitability levels as business indicators of impairment for the long-lived assets of each of these reporting units. Based on the results of the recoverability test, we determined that the future undiscounted cash flows expected to result from the use of the assets and their eventual disposition exceeded the carrying value of the asset groups and were therefore recoverable. We did not recognize any impairment charges for long-lived assets as a result of this analysis.  

During the nine months ended September 30, 2016, the summary of our re-allocations and impairment of goodwill is as follows (in thousands):

During the three months ended June 30, 2016, we entered into an amendment to our credit agreement, which, among other things, amended the interest coverage ratio and leverage ratio covenants to make them less restrictive and increased the applicable margin for the revolving credit facility and term loan by 1.0%. We paid a one-time aggregate fee of $1.7 million to the lenders for the amendment, which we recorded as a debt discount of $1.5 million related to the term loan and prepaid debt issuance costs of $0.2 million related to the revolving credit facility. In addition, we paid $0.4 million in third-party fees, which we recorded as expense of $0.3 million related to the term loan and as prepaid debt issuance costs of $0.1 million related to the revolving credit facility.

Since the recording of the amendment was a modification of our previous credit agreement, we will continue to amortize the debt discount and prepaid issuance costs on our previous credit agreement. During the three and nine months ended September 30, 2016, we amortized, as interest expense, $0.6 million and $1.9 million, respectively, of the total debt discount and prepaid debt issuance costs.

During the nine months ended September 30, 2016, we recorded initial restructuring charges primarily due to ceasing use of office facilities. We also recorded subsequent plan adjustments in sublease income assumptions for certain properties included in our previously-disclosed plans. We include the initial charges and plan adjustments in "Exit activities, restructuring and impairments" in the accompanying statements of operations and comprehensive loss for the three and nine months ended September 30, 2016 and 2015.

The following table displays the transactions and balances for exit activities and restructuring charges, substantially related to our data center and network services segment, during the nine months ended September 30, 2016 and 2015 (in thousands):

Foreign Currency Contracts

We have foreign currency contracts to mitigate the risk of a portion of our Canadian compensation expense. These contracts will hedge foreign exchange variations between the United States and Canadian dollar and commit us to purchase a total of $12.0 million Canadian dollars at an exchange rate of 1.2855 through June 2017. As of September 30, 2016 and December 31, 2015, the fair value of our foreign currency contracts was $0.1 million and $0.7 million, respectively, included in "Other current liabilities," and $0 and $0.3 million, respectively, included in "Other long-term liabilities," in the accompanying consolidated balance sheets.

The activity of the foreign currency contracts was as follows (in thousands):

Interest Rate Swap

We have an interest rate swap to manage exposure to interest rate movements of our credit agreement. Our interest rate swap involves the receipt of variable rate amounts from a counterparty in exchange for us making fixed-rate payments, over 1.5%, over the life of the agreement without exchange of the underlying notional amount. The cash flow hedge has a notional amount starting at $150.0 million through December 31, 2016.

As of September 30, 2016 and December 31, 2015, the fair value of our interest rate swap was $0.2 million and $0.7 million, respectively, and is included in "Other current liabilities" in the accompanying consolidated balance sheets. We record the effective portion of the change in fair value of our interest rate swap in "Accumulated items of other comprehensive loss" in the accompanying consolidated balance sheets. We did not recognize any hedge ineffectiveness during either of the three and nine months ended September 30, 2016 and 2015.

We will reclassify amounts reported in "Accumulated items of other comprehensive loss" related to our interest rate swaps to "Interest expense" in our accompanying consolidated statements of operations and comprehensive loss as we accrue interest payments on our variable-rate debt. Through December 31, 2016, we estimate that we will reclassify an additional $0.2 million as an increase to interest expense since the hedge interest rate currently exceeds the variable interest rate on our debt.

The activity of our interest rate swap is summarized as follows (in thousands):

We are subject to legal proceedings, claims and litigation arising in the ordinary course of business. Although the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse impact on our financial condition, results of operations or cash flows.

During the three months ended March 31, 2016, we changed our organizational structure in an effort to create more effective and efficient business operations and to improve customer and product focus. In that regard, we revised the information that our chief executive officer, who is also our chief operating decision maker, regularly reviews for purposes of allocating resources and assessing performance.  As a result, beginning January 1, 2016, we now report our financial performance based on our two new reportable segments, Data Center and Network Services and Cloud and Hosting Services, as follows:

Data Center and Network Services

Our Data Center and Network Services segment consists of colocation and Internet Protocol ("IP") connectivity services.

Colocation

Colocation involves providing physical space within data centers and associated services such as power, interconnection, environmental controls, monitoring and security while allowing our customers to deploy and manage their servers, storage and other equipment in our secure data centers. We sell our colocation services at 51 data centers across North America, Europe and the Asia-Pacific region. We refer to 15 of these facilities as "company-controlled," meaning we control the data center operations, staffing and infrastructure and have negotiated long-term leases for the facilities. For company-controlled facilities, in most cases we design the data center infrastructure, procure the capital equipment, deploy the infrastructure and are responsible for the operation and maintenance of the facility. We refer to the remaining 36 data centers as "partner" sites. In these locations, a third party designs and deploys the infrastructure and provides for the operation and maintenance of the facility.

IP Connectivity

IP connectivity includes our patented Performance IP™ service, content delivery network services, IP routing hardware and software platform and Managed Internet Route Optimizer™ Controller. By intelligently routing traffic with redundant, high-speed connections over multiple, major Internet backbones, our IP connectivity provides high-performance and highly-reliable delivery of content, applications and communications to end users globally. We deliver our IP connectivity through 83 IP service points around the world.

Cloud and Hosting Services

Our cloud and hosting services segment consists of hosted Infrastructure-as-a-Service as a cloud platform or via managed hosting. For both Infrastructure-as-a-Service options, we provision and maintain the hardware, data center infrastructure and interconnection, while allowing our customers to own and manage their software applications and content.

Cloud

Cloud services involve providing compute and storage services via an integrated platform that includes servers, storage and network. We built our next generation cloud platform with our high-density colocation, Performance IP service and OpenStack, a leading open source technology for cloud services. We deliver our cloud services in eight locations across North America, Europe and the Asia-Pacific region.

Managed Hosting

Managed hosting involves providing a single tenant infrastructure environment consisting of servers, storage and network. We deliver this customizable infrastructure platform based on enterprise-class technology to support complex application and compliance requirements for our customers. We deliver our managed hosting services in 11 locations across North America, Europe and the Asia-Pacific region.

Segment Results

The following table provides segment results, with prior period amounts reclassified to conform to the current presentation (in thousands):

The prior year reclassifications, which did not affect total segment profit, are summarized as follows (in thousands):

Segment profit is calculated as segment revenues less direct costs of sales and services, exclusive of depreciation and amortization for the segment, and does not include any depreciation or amortization associated with direct costs. We view direct costs of sales and services as generally less-controllable, external costs and we regularly monitor the margin of revenues in excess of these direct costs. We have excluded depreciation and amortization from segment profit because it is based on estimated useful lives of tangible and intangible assets. We base depreciation and amortization on historical costs incurred to build out our deployed network and the historical costs of these assets may not be indicative of current or future capital expenditures.

11. NET LOSS PER SHARE

We compute basic net loss per share by dividing net loss attributable to our common stockholders by the weighted average number of shares of common stock outstanding during the period. We exclude all outstanding options and unvested restricted stock as such securities are anti-dilutive for all periods presented.

Basic and diluted net loss per share is calculated as follows (in thousands, except per share amounts):

12. RECENT ACCOUNTING PRONOUNCEMENTS

In October 2016, the Financial Accounting Standards Board ("FASB") issued new guidance which allows the recognition of current and deferred income taxes for an intra-entity asset transfer, other than inventory, when the transfer occurs. Historically, recognition of the income tax consequence was not recognized until the asset was sold to an outside party. This guidance should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. There are no new disclosure requirements. The guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2017 with early adoption permitted.  We are currently evaluating the impact that adoption will have on our consolidated financial statements.

In August 2016, FASB issued new guidance intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. The guidance provides additional clarification on the classification of certain cash receipts and payments in the statement of cash flows. The guidance is effective for fiscal years and interim periods within those years beginning after December 15, 2017 with early adoption permitted. We are currently evaluating the impact that adoption will have on the presentation of our consolidated statements of cash flow.

During the three months ended March 31, 2016, we adopted new guidance that required debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, which is consistent with the presentation of debt discounts. The guidance, applied retrospectively, was effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Adoption did not have a material impact on our financial condition and had no impact on our result of operations. Our restatement of prior year amounts was as follows:

In March 2016, FASB issued new guidance that amends several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification within the statement of cash flows. Certain of the amendments in this accounting standard update are to be applied using a modified retrospective approach by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted, while other amendments can be applied prospectively or retrospectively. The guidance is effective for periods beginning after December 15, 2016. We are currently evaluating the impact that adoption will have on our consolidated financial statements and related disclosures.

In February 2016, FASB issued new guidance on lease accounting, which requires all leases in excess of 12 months to be recognized on the balance sheet as lease assets and lease liabilities. For operating leases, a lessee is required to recognize a right-of-use asset and lease liability, initially measured at the present value of the lease payment; recognize a single lease cost over the lease term generally on a straight-line basis; and classify all cash payments within operating activities on the cash flow statement. The guidance is effective for annual and interim periods beginning after December 15, 2018. Earlier adoption is permitted. We are currently evaluating the impact that adoption will have on our consolidated financial statements and related disclosures.

In August 2014, FASB issued new guidance which requires management to evaluate, in connection with preparing financial statements for each annual and interim reporting period, whether there are conditions or events, considered in the aggregate, that raise substantial doubt about an entity's ability to continue as a going concern within one year after the date the financial statements are issued (or within one year after the date that the financial statements are available to be issued when applicable) and provide related disclosures. The guidance is effective for the annual and interim periods ending after December 15, 2016. We are currently evaluating the impact that adoption will have on our consolidated financial statements and related disclosures.

In May 2014, FASB issued new guidance which provides a single model for revenue arising from contracts with customers and supersedes current revenue recognition guidance. The guidance is effective for periods beginning January 1, 2018. The guidance permits the application of its requirements retrospectively to all prior periods presented or in the year of adoption through a cumulative adjustment. We are currently evaluating the impact that adoption will have on our consolidated financial statements and related disclosures. As we have not completed our evaluation, we cannot make a determination of the impact and have not yet selected a transition method or determined the impact of the standard on our ongoing financial reporting.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements regarding industry trends, our future financial position and performance, business strategy, revenues and expenses in future periods, projected levels of growth and other matters that do not relate strictly to historical facts. These statements are often identified by words such as "may," "will," "seeks," "anticipates," "believes," "estimates," "expects," "projects," "forecasts," "plans," "intends," "continue," "could" or "should," that an "opportunity" exists, that we are "positioned" for a particular result, statements regarding our vision or similar expressions or variations. These statements are based on the beliefs and expectations of our management team based on information currently available. Such forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated by forward-looking statements. Important factors currently known to our management that could cause or contribute to such differences include, but are not limited to, those referenced in our Annual Report on Form 10-K for the year ended December 31, 2015 under Item 1A "Risk Factors." We undertake no obligation to update any forward-looking statements as a result of new information, future events or otherwise.

As used herein, except as otherwise indicated by context, references to "we," "us" or "our" refer to Internap Corporation and our subsidiaries.

Overview

Internap's diverse Internet infrastructure services deliver "performance without compromise" – blending virtual and bare-metal cloud, hosting and colocation services across a global network of data centers, optimized from the application to the end user and backed by our team of dedicated professionals.

Change in Organizational Structure and Realignment of Expenses

During the three months ended March 31, 2016, we changed our organizational structure in an effort to create more effective and efficient business operations and to improve customer and product focus. In that regard, we revised the information that our chief executive officer, who is also our chief operating decision maker, regularly reviews for purposes of allocating resources and assessing performance. As a result, beginning January 1, 2016, we report our financial performance based on our two new segments, data center and network services and cloud and hosting services. The new operating segments are further described in note 10 "Operating Segments" in the accompanying consolidated financial statements. We have reclassified prior period amounts to conform to the current presentation.

In addition, in conjunction with the change in our organizational structure, we reclassified certain costs included in the expense categories on our consolidated statement of operations, which resulted in the following: a reclassification of "Sales and marketing" and "General and administrative" to "Sales, general and administrative" ("SGA") and "Direct costs of amortization of acquired and developed technologies" to "Depreciation and amortization" included on our accompanying consolidated statements of operations. We have reclassified prior period amounts to conform to the current presentation. SGA expense consists primarily of costs related to sales and marketing, compensation and other expense for executive, finance, product development, human resources and administrative personnel, professional fees and other general corporate costs.

Recent Accounting Pronouncements

Recent accounting pronouncements are summarized in note 12 to the accompanying consolidated financial statements.

Results of Operations

As of September 30, 2016, we had approximately 9,000 customers. Our customer base is not concentrated in any particular industry and, for the three and nine months ended September 30, 2016, no single customer accounted for 10% or more of our revenues.

Three Months Ended September 30, 2016 and 2015

The following table sets forth selected consolidated statements of operations and comprehensive loss data during the periods presented, including comparative information between the periods (dollars in thousands):

Data Center and Network Services

Revenues for data center and network services decreased 5%, to $49.8 million for the three months ended September 30, 2016, compared to $52.4 million for the same period in 2015. The decrease was primarily due to $2.5 million of lower IP connectivity revenue related to the continued decline in pricing for new and renewing customers and loss of legacy contracts and a $0.4 million decrease in partner colocation revenue, offset by a net $0.2 million increase in company-controlled colocation revenue.

Direct costs of data center and network services, exclusive of depreciation and amortization, decreased 6%, to $25.0 million for the three months ended September 30, 2016, compared to $26.7 million for the same period in 2015. The decrease was primarily due to lower variable costs related to a decline in revenue and cost reduction efforts.

Cloud and Hosting Services

Revenues for cloud and hosting services decreased 7% to $24.2 million for the three months ended September 30, 2016, compared to $25.9 million for the same period in 2015. The decrease is primarily due to the continued negative impact of churn from a small number of large customers.

Direct costs of cloud and hosting services, exclusive of depreciation and amortization, decreased 6%, to $6.5 million for the three months ended September 30, 2016, compared to $6.9 million for the same period in 2015. The decrease was primarily due to lower variable costs related to a decline in revenue.

Other Operating Costs and Expenses

Compensation. Total compensation and benefits, including stock-based compensation, was $16.2 million for the three months ended September 30, 2016, compared to $19.7 million for the same period in 2015. The decrease was primarily due to a $2.4 million decrease in cash-based compensation and bonus and a $1.2 million decrease in stock-based compensation.

Stock-based compensation, net of amount capitalized, decreased to $1.3 million during the three months ended September 30, 2016 from $2.4 million during the same period in 2015. The decrease is primarily due to executive transition awards in the prior period for our former chief executive officer. The following table summarizes stock-based compensation, net of estimated forfeitures, included in the accompanying consolidated statements of operations and comprehensive loss (in thousands):

Direct Costs of Customer Support. Direct costs of customer support decreased to $8.0 million during the three months ended September 30, 2016 compared to $9.2 million during the same period in 2015. The decrease was primarily due to decreased cash-based compensation from reduced headcount.

Sales, General and Administrative . Sales, general and administrative costs decreased to $18.4 million during the three months ended September 30, 2016 compared to $19.1 million during the same period in 2015. The decrease was primarily due to a $1.8 million decrease in cash-based compensation from reduced headcount and bonus and a $1.0 million decrease in stock-based compensation, partially offset by a $0.8 million increase in professional fees and a $1.6 million increase in organizational realignment costs and strategic alternatives and related costs.

Depreciation and Amortization. Depreciation and amortization decreased to $19.6 million during the three months ended September 30, 2016 compared to $24.6 million during the same period in 2015. The decrease was primarily due to the additional amortization expense in the prior period of $4.5 million for the accelerated useful life of the iWeb trade name.

Goodwill Impairment. The goodwill impairment was $78.2 million during the three months ended September 30, 2016 compared to $0 during the same period in 2015. We summarize the goodwill impairment in note 5 to the accompanying consolidated financial statements.

Exit activities, Restructuring and Impairments. Exit activities, restructuring and impairments increased to $1.7 million during the three months ended September 30, 2016 compared to $0.9 million during the same period in 2015. The increase was primarily due to impairment of internally-developed software for $1.6 million in the current period, which we summarize in note 4 to the accompanying consolidated financial statements.

Interest Expense . Interest expense increased to $7.9 million during the three months ended September 30, 2016 from $6.9 million during the same period in 2015. The increase is primarily due to the higher interest rate from the debt amendment completed in the period ended June 30, 2016 and increased borrowings on the revolving credit facility.

Nine Months Ended September 30, 2016 and 2015

The following table sets forth selected consolidated statements of operations and comprehensive loss data during the periods presented, including comparative information between the periods (dollars in thousands):

Data Center and Network Services

Revenues for data center and network services decreased 6%, to $151.1 million for the nine months ended September 30, 2016, compared to $160.0 million for the same period in 2015. The decrease was primarily due to $8.8 million of lower IP connectivity revenue related to the continued decline in pricing for new and renewing customers and loss of legacy contracts and a $2.5 million decrease in partner colocation revenue, offset by a net $2.3 million increase in company-controlled colocation revenue.

Direct costs of data center and network services, exclusive of depreciation and amortization, decreased 7%, to $74.1 million for the nine months ended September 30, 2016, compared to $79.3 million for the same period in 2015. The decrease was primarily due to lower variable costs related to a decline in revenue and cost reduction efforts.

Cloud and Hosting Services

Revenues for cloud and hosting services decreased 8% to $73.1 million for the nine months ended September 30, 2016, compared to $79.5 million for the same period in 2015. The decrease is primarily due to the continued negative impact of churn from a small number of large customers.

Direct costs of cloud and hosting services, exclusive of depreciation and amortization, decreased 4%, to $19.9 million for the nine months ended September 30, 2016, compared to $20.7 million for the same period in 2015. The decrease was primarily due to lower variable costs related to a decline in revenue.

Other Operating Costs and Expenses

Compensation. Total compensation and benefits, including stock-based compensation, was $51.7 million for the nine months ended September 30, 2016, compared to $61.8 million for the same period in 2015. The decrease was primarily due to a $7.7 million decrease in cash-based compensation and bonus, a $0.9 million decrease in severance and a $1.5 million decrease in stock-based compensation.

Stock-based compensation, net of amount capitalized, decreased to $4.7 million during the nine months ended September 30, 2016 from $6.2 million during the same period in 2015. The decrease is primarily due to executive transition awards in the prior period for our former chief executive officer and a decrease in the fair value of stock options and awards. The following table summarizes stock-based compensation, net of estimated forfeitures, included in the accompanying consolidated statements of operations and comprehensive loss (in thousands):

Direct Costs of Customer Support. Direct costs of customer support decreased to $24.7 million during the nine months ended September 30, 2016 compared to $27.4 million during the same period in 2015. The decrease was primarily due to a $1.5 million decrease in cash-based compensation from reduced headcount and bonus and a $0.5 million decrease in professional fees.

Sales, General and Administrative . Sales, general and administrative costs decreased to $55.4 million during the nine months ended September 30, 2016 compared to $62.6 million during the same period in 2015. The decrease was primarily due to a $6.2 million decrease in cash-based compensation from reduced headcount and bonus, a $1.2 million decrease in stock-based compensation, a $2.4 million decrease in marketing costs and a $0.9 million decrease in severance, partially offset by a $4.6 million increase in organizational realignment costs and strategic alternatives and related costs.

Depreciation and Amortization. Depreciation and amortization decreased to $57.9 million during the nine months ended September 30, 2016 compared to $67.4 million during the same period in 2015. The decrease was primarily due to the additional amortization expense in the prior period of $9.5 million for the accelerated useful life of the iWeb trade name.

Goodwill Impairment. The goodwill impairment was $78.2 million during the nine months ended September 30, 2016 compared to $0 during the same period in 2015. We summarize the goodwill impairment in note 5 to the accompanying consolidated financial statements.

Exit activities, Restructuring and Impairments. Exit activities, restructuring and impairments increased to $2.0 million during the nine months ended September 30, 2016 compared to $1.2 million during the same period in 2015. The increase was primarily due to impairment of internally-developed software for $1.6 million, which we summarize in note 4 to the accompanying consolidated financial statements.

Interest Expense . Interest expense increased to $22.9 million during the nine months ended September 30, 2016 from $20.6 million during the same period in 2015. The increase is primarily due to the higher interest rate from the recent debt amendment and increased borrowings on the revolving credit facility.

Non-GAAP Financial Measure

We report our consolidated financial statements in accordance with GAAP. We present the non-GAAP performance measure of adjusted EBITDA to assist us in explaining underlying performance trends in our business, which we believe will enhance investors' ability to analyze trends in our business and evaluate our performance relative to other companies. We define adjusted EBITDA as loss from operations plus depreciation and amortization, loss on disposal of property and equipment, exit activities, restructuring and impairments, stock-based compensation, strategic alternatives and related costs, organizational realignment costs and acquisition costs.

As a non-GAAP financial measure, adjusted EBITDA should not be considered in isolation of, or as a substitute for, net loss, loss from operations or other GAAP measures as an indicator of operating performance. Our calculation of adjusted EBITDA may differ from others in our industry and is not necessarily comparable with similar titles used by other companies.

The following table reconciles adjusted EBITDA to loss from operations as presented in our consolidated statements of operations and comprehensive loss:

Liquidity and Capital Resources

Liquidity

As of September 30, 2016, we had a deficit in working capital, which represented an excess of current liabilities over current assets, primarily due to our decrease in cash since December 31, 2015. We are addressing the decrease through increased accounts receivable collection and continued cost reduction efforts. However, we believe that cash flows from operations, together with our cash and cash equivalents and borrowing capacity under our revolving credit facility, will be sufficient to meet our cash requirements for the next 12 months and for the foreseeable future. If our cash requirements vary materially from what we expect or if we fail to generate sufficient cash flows from selling our services, we may require additional financing sooner than anticipated. We can offer no assurance that we will be able to obtain additional financing on commercially favorable terms, or at all, and provisions in our credit agreement limit our ability to incur additional indebtedness.

We have a history of quarterly and annual period net losses. During the three and nine months ended September 30, 2016, we had a net loss of $91.3 million and $111.6 million, respectively. As of September 30, 2016, our accumulated deficit was $1.3 billion.

Capital Resources

Credit Agreement . We have a $350.0 million credit agreement, which provides for a $300.0 million term loan and a $50.0 million revolving credit facility. During the three months ended June 30, 2016, we entered into an amendment to our credit agreement, which among other things, amended the interest coverage ratio and leverage ratio covenants to make them less restrictive and increased the applicable margin for revolving credit facility and term loan by 1.0%. We paid a one-time aggregate fee of $1.7 million to the lenders for the amendment.

As of September 30, 2016, the term loan had an outstanding principal amount of $291.8 million, which we repay in $0.75 million quarterly installments on the last day of each fiscal quarter with the remaining unpaid balance due November 26, 2019. As of September 30, 2016, the revolving credit facility, expiring in November 2018, had an outstanding balance of $35.5 million and we issued $4.2 million in letters of credit, resulting in $10.3 million in borrowing capacity. As of September 30, 2016, the interest rate on the term loan was 7% and the interest rate on the revolving credit facility was 6%.

The credit agreement includes customary representations, warranties, negative and affirmative covenants, including certain financial covenants relating to maximum total leverage ratio, minimum consolidated interest coverage ratio and limitation on capital expenditures. As of September 30, 2016, we were in compliance with these covenants.

Cash Flows

Operating Activities

During the nine months ended September 30, 2016, net cash provided by operating activities was $36.3 million. We generated cash from operations of $31.9 million, while changes in operating assets and liabilities provided cash of $4.4 million.

During the nine months ended September 30, 2015, net cash provided by operating activities was $22.4 million. We generated cash from operations of $36.0 million, while changes in operating assets and liabilities used cash from operations of $13.6 million.

Investing Activities

During the nine months ended September 30, 2016 and 2015, net cash used in investing activities was $39.4 million and $42.4 million, respectively, primarily due to capital expenditures related to the continued expansion and upgrade of our company-controlled data centers and network infrastructure.

Financing Activities

During the nine months ended September 30, 2016, net cash used by financing activities was $5.0 million, primarily due to principal payments of $9.5 million on the term loan and capital lease obligations, partially offset by $4.5 million of proceeds from the revolving credit facility.

During the nine months ended September 30, 2015, net cash provided by financing activities was $18.6 million, primarily due to $21.0 million of proceeds from the revolving credit facility and a net $4.7 million from stock option activity, partially offset by principal payments of $8.0 million on the term loan and capital lease obligations.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Other Investments

In previous years, we invested $4.1 million in Internap Japan Co., Ltd., our joint venture with NTT-ME Corporation and Nippon Telegraph and Telephone Corporation. We account for this investment using the equity method and we have recognized $1.2 million in equity-method losses over the life of the investment, representing our proportionate share of the aggregate joint venture losses and income. The joint venture investment is subject to foreign currency exchange rate risk.

Interest Rate Risk

Our objective in managing interest rate risk is to maintain favorable long-term fixed rate or a balance of fixed and variable rate debt within reasonable risk parameters. At September 30, 2016, we had an interest rate swap on 50% of our current term loan balance through December 31, 2016 with a LIBOR floor fixed rate of 1.5%.

As of September 30, 2016, the balance of our long-term debt was $291.8 million on the term loan and $35.5 million on the revolving credit facility. At September 30, 2016, the interest rates on the term loan and revolving credit facility were 7% and 6%, respectively. We summarize the credit agreement in "Liquidity and Capital Resources-Capital Resources-Credit Agreement."

We are required to pay a commitment fee at a rate of 0.50% per annum on the average daily unused portion of the revolving credit facility, payable quarterly in arrears. In addition, we are required to pay certain participation fees and fronting fees in connection with standby letters of credit issued under the revolving credit facility.

We estimate that a change in the interest rate of 100 basis points would change our interest expense and payments by $3.3 million per year, assuming we do not increase our amount outstanding.

Foreign Currency Risk

As of September 30, 2016, the majority of our revenue was in U.S. dollars. However, our results of operations and cash flows are subject to fluctuations in foreign currency exchange rates. We also have exposure to foreign currency transaction gains and losses as the result of certain receivables due from our foreign subsidiaries. During the three and nine months ended September 30, 2016, we realized foreign currency gains of less than $0.1 million and losses of $0.5 million, respectively, which we included in "Non-operating expenses," and we recorded unrealized foreign currency translation gains of $0.1 million and $0.2 million, respectively, which we included in "Other comprehensive loss," both in the accompanying consolidated statement of operations and comprehensive loss. If we grow our international operations, our exposure to foreign currency risk will become more significant.

We have foreign currency contracts to mitigate the risk of a portion of our Canadian employee benefit expense. These contracts will hedge foreign exchange variations between the United States and Canadian dollar through June 30, 2017. During the three and nine months ended September 30, 2016, we recorded an unrealized loss of $0.1 million and an unrealized gain of $0.6 million, respectively, which we included in "Other comprehensive loss," in the accompanying consolidated statement of operations and comprehensive loss.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Based on our management's evaluation (with the participation of our chief executive officer and chief financial officer), as of the end of the period covered by this report, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2016 that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We are subject to legal proceedings, claims and litigation arising in the ordinary course of business. Although the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse impact on our financial condition, results of operations or cash flows.

ITEM 1A. RISK FACTORS

We believe that there have been no material changes from the Risk Factors we previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2015 filed with the Securities and Exchange Commission on February 18, 2016.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table sets forth information regarding our repurchases of securities for each calendar month in the three months ended September 30, 2016:

ISSUER PURCHASES OF EQUITY SECURITIES

ITEM 6. EXHIBITS

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.